Bad Assets not the Problem; its the Banks and Consumers Stupid!

Treasury Secretary Henry Paulson announced that he has shelved the original plan to buy troubled mortgage assets via the recently approved $700 Billion Troubled Asset Relief Program (TARP). Instead he will use the remaining funds to assist non-bank financial institutions and promote consumer finance initiatives. In a striking admission, Paulson said that buying up distressed mortgage assets “is not the most effective way” to use government funding. “Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy.”

Purchasing these so-called “toxic” assets was once the cornerstone of the rescue plan for financial markets and was almost the entire focus of Congress when the TARP package was being debated before its enactment in September. But almost as soon as Treasury received the money, it decided that giving capital to banks in return for preferred stock was a better use of the funds. Some analysts have accused Paulson of “flip-flopping” on every plan and it doesn’t look like he has a plan at all.

No definitive plan has been identified as to how the redirected efforts of the TARP will take place. “We are carefully evaluating programs which would further leverage the impact of a TARP investment by attracting private capital, potentially through matching investments,” Paulson said. “In developing a potential matching program, we will also consider capital needs of nonbank financial institutions not eligible for the current capital program; broadening access in this way would bring both benefits and challenges.”

Paulson’s remarks are an acknowledgment that the pitch he made to Congress for the bailout hasn’t delivered what was promised. Paulson sold the TARP as a way to rid bank balance sheets of illiquid mortgage assets, and he may encounter resistance from Congress for the remaining $350 billion after using most of the first half to buy bank stakes and assist distressed insurer American International Group (AIG). Lawmakers will “put his feet to the fire,” said Kevin Petrasic, a former official at the Office of Thrift Supervision. Paulson said he has no regrets for the revised plan. “I will never apologize for changing a strategy or an approach if the facts change.”

Paulson said he has no timeline for notifying Congress of his intent to use the remaining TARP funds, and reiterated that he’s “comfortable” that $700 billion is “what we need” to stabilize the financial system. This arrogance is not going to sit well with Congress or voters. President-Elect Barack Obama who assumes the U.S. presidency on January 20th, said last week his economic team will “review the implementation” of the rescue plan, suggesting he may have different priorities for its use. It is also likely that Obama will replace Paulson based on recent transition reports.

Asked about possible aid for the automobile industry using the TARP, Mr. Paulson said, “My focus is on the financial sector.” Thus, while declaring that “we care about our auto industry,” he ruled out any role in the TARP effort for bailing out Detroit, an issue that is now occupying Congress, President-elect Barack Obama and President Bush.

I don’t think the new direction being taken for the TARP is wrong, its just that every time Paulson changes course the longer it takes for the TARP actions and benefits to flow through. I also feel that more than $700 billion will be needed over the next few years (just look at the relative size of China’s recent Economic Stimulus), meaning that the next treasury chief will have to go to Congress hat in hand to ask for more tax payer funds. It is more than likely though that a Democratic President and Congress will approve the additional funds. I just hope after months of talking and politicking the brains behind the TARP have got a real plan in place that they can execute on now, rather than “flip-flopping” as events unfold. If we have until the presidential transition before anything happens, the economy and our own individual situations will have gotten significantly worse.

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